CORPORATION AND LLC FORMATION AND GOVERNANCE

Entity Selection

Selecting the right business entity for your situation is critical. Corporations and Limited Liability Companies (LLCs) are valuable tools for entrepreneurs and investors and have many benefits over operating as a sole proprietorship. Significant tax savings and liability protection can be gained from selecting the right entity and structuring it properly. Partnerships can also be useful in certain niche situations like real estate investments.

Corporations and LLCs segregate the liabilities of your business from your personal assets unlike sole proprietorships where your personal assets and the assets of your sole proprietorship business are one and the same in the eyes of the law. In other words, if you operate your business through a Corporation or LLC and the business is sued and the plaintiff obtains a judgment, that judgment can only be executed against assets of the business in the Corporation or LLC. Your personal assets (e.g. your house and savings) are not exposed to the judgment.

In addition to the asset protection that Corporations and LLCs can provide, there can also be important income tax benefits in the form of payroll tax savings and obtaining capital gains tax treatment upon the disposition of certain assets. An exhaustive list is not practical here, but here are two examples:

An “S” corporation can allow a sole proprietor the ability to save thousands of dollars in payroll tax by allowing an individual to paying himself/herself a “reasonable” salary and then taking the remainder of his/her earnings as a distribution. As a shareholder, the individual will pay payroll tax on the salary component but none on the distribution component.

If an individual is already operating his/her business through a corporation, for example, and that individual is considering buying a commercial property, the commercial property should not be purchased by the corporation. Instead, use a separate limited liability company (LLC) to purchase and hold title to the real estate. Upon later sale of the real estate (assuming it is held more than one year), the gain will only be taxed as long term capital gains (currently, 15% or 20% depending on your tax bracket). Assuming the individual owner(s) are in a higher tax bracket, the difference between paying tax at ordinary income tax rates and long term capital gains tax rates, could be a savings of tens of thousands of dollars if not hundreds of thousands of dollars depending on the value of the real estate and the appreciation.

Formation Services

While LegalZoom® and other third parties offer extremely low prices to form your business entity, and admittedly the filing the Articles of Incorporation (Corporations) or Articles of Organization (LLCs) is relatively straightforward, you would be better served by hiring an attorney to form your entities (whether you hire me or some other qualified law firm/attorney) because, regardless of your situation, you will benefit from legal advice tailored to your situation.

Your specific situation will dictate the choice of entity and how to structure the ownership and management of that entity. You do not get that type of personal attention with LegalZoom® and other similar “do-it-yourself” websites no matter what they say or offer. Moreover, the documents that are produced by LegalZoom® lack substance and only repeat the default rules already found in the statutes/codes. They do not take you through different scenarios, answer your questions and thoughtfully build your entity. They only churn out template entities and documents which are often not properly completed by the business owner, which could lead to piercing the corporate veil (the loss of liability protection), the very thing you wished to accomplish by using a Corporation or LLC in the first place.

I have spent many hours cleaning up entities that clients tried to form on LegalZoom.® Surprisingly, that’s actually a best case scenario – figuring out that there is a deficiency before it turns into a problem. The far worse situation is when I have to deal with trying to get clients out of a business or a resolve dispute with a co-owner or investor when a resolution (or at least a roadmap to a resolution) should have been pre-negotiated at the formation of the entity with more thoughtful, robust legal documents.

Buy-Sell Agreements, Shareholders Agreements, Operating Agreements

Once the right entity is selected and formed, it is important to take that next step to have an agreement among the owners of the business drafted by an experienced attorney. While you might disregard the recommendation against using LegalZoom® or a similar service to form your entity, it is strongly recommended that you do not rely on the short-form template Shareholders Agreement or Operating Agreement that comes with the “kit.” All those template agreements do is regurgitate the default rules embodied in the statutes/code and do very little to actually reflect the agreements among the owners of the business. The default rules are simply not sufficient.

If there is more than one owner in the business, retaining a qualified attorney to prepare an agreement among the owners will prove to be extremely valuable. If you are the sole shareholder of a Corporation or the sole member of an LLC, obviously, this is less important. Pointing out issues, providing an explanation of the advantages, disadvantages, and potential consequences, as well as guiding the owners through the myriad of issues to be considered can only be appropriately accomplished by an experienced attorney. I have drafted a countless number of these documents and can efficiently guide you through this process.

International Business Structures

In a growing global economy, I am more and more frequently encountering clients who do a sizeable level of business outside the United States. Some very enticing planning opportunities exist for some businesses depending on type of business, gross revenues, margins and other particular facts and circumstances. For instance, many technology companies that make their money by commercially exploiting their intellectual property (e.g. software companies, internet companies, pharmaceutical companies, etc.) can realize tremendous tax savings by doing their research and development offshore in a foreign structure set up in jurisdictions with favorable tax laws and infrastructure.

The United States has the highest corporate tax rates of any developed country in the entire world. For this reason, you continue to see many U.S companies exploring ways to move a portion of their business outside offshore. While the United States continues to have a tax system where its corporations are taxed on their worldwide income, the tax is imposed only when the funds are brought back to the United States (assuming the foreign operations are properly structured). If you can sustain U.S. operations and your lifestyle from the cash flow from U.S. sales and forgo bringing the profits back to the United States, you can defer U.S. taxation. Better than simply deferring taxation, you can use your new bigger foreign war chest of cash to grow your non-U.S. business by either making larger investments in research and development or making acquisitions of foreign companies.

Of course, much of the magic of setting up these structures lies in having a good international tax lawyer. While I am not a tax lawyer, I work closely with other lawyers in town and can build a team of professionals to help analyze the suitability of a foreign structure for your business and your situation. If the circumstances are promising, we work together as a team to execute the plan and implement efficiently.